Risk-adjusted returns

What are risk-adjusted returns?

Risk-adjusted returns measure the performance of an investment after accounting for the risk that’s involved in generating the investment’s returns. Risk-adjusted returns may provide a clearer picture of performance by factoring in the inherent risks involved in investments. Therefore, the measurement allows investors the potential to understand how much return they are actually receiving for the amount of risk that they take on, which can allow them to make more informed investment decisions.

The Sharpe ratio is the most commonly used metric to look at risk-adjusted returns. It calculates the excess return per unit of risk (standard deviation). However, the Treynor ratio also calculates risk-adjusted returns—but it does so by looking at systematic risk instead of standard deviation. Either way, higher risk-adjusted returns may indicate more efficient investments (better returns for the level of risk taken).

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